This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.
After a devastating drop to begin the year, the U.S. stock market has rallied tremendously over the past month. Despite the recent rally, the S&P 500 Index remains down 6% year-to-date, and stocks have exhibited high volatility. To make matters worse, the U.S. economy has officially entered a recession. All of this adds up to a high level of uncertainty, and investors may want to focus on quality dividend payers in this environment.
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In the search for high-quality dividend stocks, investors might take their cues from legendary value investor Warren Buffett, Chairman of investment conglomerate Berkshire Hathaway (BRK.B). Warren Buffett stocks have a number of similar qualities, including reasonable valuations, competitive advantages, and attractive dividend yields.
We believe three stocks in Berkshire Hathaway’s investment portfolio are particularly attractive for value and income investors in a highly uncertain market.
Berkshire Hathaway Stock #1: The Coca-Cola Company (KO)
- Dividend Yield: 3.6%
Coca-Cola is the world’s largest beverage company, as it owns or licenses more than 500 unique non-alcoholic brands. The company sells its products in more than 200 countries worldwide. Coca-Cola has a market capitalization of nearly $200 billion.
Coca-Cola is arguably the most recession-resistant stock in Berkshire Hathaway’s entire portfolio. The reason is simple—consumption of food and beverages remains stable during economic downturns. This is how Coca-Cola has managed to increase its dividend each year for over 50 years in a row. The past five decades has included multiple wars, recessions, and other global challenges. But Coca-Cola continued to raise its dividend each year, regardless of the state of the broader economy.
Warren Buffett popularized the term economic “moat” to describe a company that can resist competitive threats, just as a moat protects a castle from invasion. Coca-Cola is a great example of a company with a wide economic moat, as it commands top market share in the beverage industry due to its world-class brand. According to Forbes, Coca-Cola is the world’s 6th most valuable brand.
This gives Coca-Cola a durable competitive advantage, which has fueled the company’s growth over the past several decades. We believe Coca-Cola has plenty of growth in store, as the company has expanded and diversified its product portfolio. Specifically, Coca-Cola is making major inroads in ready-to-drink coffees and teas, which are a growth category within the global beverages industry.
Coca-Cola acquired Costa in a ~$5 billion acquisition, which gave it even greater exposure to coffee. Costa has operations in more than 30 countries. The acquisition provides Coca-Cola with an enhanced presence in a growing category, particularly in the emerging markets.
Coca-Cola stock trades for a 2020 P/E ratio of 25, and a 2021 P/E ratio of 22 based on prevailing analyst estimates. These are higher-than-average valuation multiples, but premium companies often deserve premium valuation multiples for their relative earnings quality, and dividend safety. With a strong 3.6% dividend yield, and a long history of annual dividend increases, Coca-Cola is a top dividend growth stock.
Berkshire Hathaway Stock #2: American Express (AXP)
- Dividend Yield: 1.7%
American Express is a credit card company that operates the following business units: US Card Services, International Consumer and Network Services, Global Commercial Services, and Global Merchant Services. The stock has a market capitalization of $80 billion.
American Express reported its first-quarter earnings results on April24. The company generated revenues of $10.3 billion during the quarter, a minor decline of 0.5% from the same quarter the previous year. Revenue dropped due to lower transaction volumes, caused by the drop in consumer and business spending that was the result of the ongoing coronavirus crisis.
However, at constant currency rates, American Express would have generated 1% revenue growth for the period. Adjusted earnings-per-share were $1.98 excluding one-time impacts of the coronavirus crisis during the first quarter, which exceeded analyst estimates. The company continues to prepare for a recession by cutting costs. It also raised its provisions for loan losses from $810 million to $2.6 billion.
American Express would be adversely impacted by a recession, but the company should return to growth once the coronavirus crisis is over. The company generated approximately 10% annual earnings growth over the past decade.
The stock has a reasonable valuation, trading for a price-to-earnings ratio of approximately 13.3x based on 2021 earnings estimates of $7.35 per share. Therefore, assuming the coronavirus crisis does not extend beyond 2020, shareholders buying at the current price could be getting a blue-chip dividend stock at a bargain. The stock also has a 1.7% dividend yield, which is slightly below the S&P 500 Index average, but American Express makes up for this with steady dividend growth. With a payout ratio of just 23% based on next year’s projected earnings, the dividend appears to be highly secure.
Berkshire Hathaway Stock #3: Bank of America (BAC)
- Dividend Yield: 2.9%
Bank of America is another financial stock in the Berkshire Hathaway portfolio, and it is the second-largest holding of the portfolio. Bank of America is a diversified financial services giant, with a market capitalization above $200 billion.
It is easy to see why Bank of America is such a large holding of Berkshire Hathaway, as the company has performed relatively well to start 2020. Net income fell to $4 billion in the first quarter, down from $7.3 billion in the same quarter a year ago, but the company remained highly profitable. The steep decline was mostly due to a $3.8 billion loan loss reserve build, directly related to the coronavirus-induced economic downturn.
However, many other metrics remained strong. Net interest income declined only slightly, from $12.4 billion to $12.1 billion. This was a very resilient performance in a highly difficult environment for banks, characterized not just by the coronavirus, but also by extremely low interest rates. Average deposits and loans both grew by 6% in the first quarter. Bank of America’s loan-to-deposit ratio was 68%, which is still quite low.
Continued growth in loans and deposits, combined with cost efficiency, means Bank of America has performed admirably to start 2020. The stock appears to be undervalued, trading for a 2020 P/E ratio of 16.5 and a 2021 P/E ratio of 11. With a nearly 3% dividend yield, the stock offers value and income.
The U.S. stock market has come a long way from the lows of 2020, but markets remain extremely volatile. For investors unnerved by the U.S. economy entering a recession and heightened stock market volatility, quality dividend stocks should be in focus. Coca-Cola, American Express, and Bank of America are three high-quality dividend stocks that are a major part of Berkshire Hathaway’s investment portfolio. These three stocks should remain profitable and continue to pay their dividends even with the U.S. economy in recession, thanks to their competitive advantages and wide economic moats.